September 26, 2003
Identifying the Effects of Interlocking Directorships on Board Independence
by William Baue

A new report from The Corporate Library uncovers ways interlocking directorships impede board
independence, though shareowner activists could leverage this interlock to push corporate
governance reform.

Director independence is seen by many as a panacea to the corporate governance rot that has been
revealed over the last few years. The New York Stock Exchange (NYSE) and NASDAQ have proposed new listing standards requiring a majority
of independent outside directors on boards. However, the exchanges' definition of independence
does not prevent certain director relationships and dynamics that can undermine independence. So
says a report released earlier this week by The Corporate Library (TCL), an independent provider
of corporate governance research and analysis. The tools used to produce the report may help
shareowner activists to advocate for greater board independence.

The report,
entitled Corporate and
Director Interlocks in the USA: 2003, analyzed director interrelationships at 1,727 of the
largest corporations in the US using TCL's Interlocks Tool, which it launched in November 2002.
The study, which covers the period up to December 2002, analyzed 16, 406 directorships held by
12,794 individuals. The study particularly looks at multiple different types of interlock, or the
overlap of directors serving on multiple boards, which can create conflicts of interest.

"The biggest companies perform the best on board independence [as defined by NYSE and NASDAQ],
probably because they've got more seats to allocate to outsiders, but this kind of independence
seems to accompany less independence in other respects," said Jackie Cook, the senior research
associate with TCL who authored the report. "Looking at the number of independent outsiders does
not go nearly far enough."

"You'd think bigger boards would have enough seats to appoint a chairperson who's separate
from the CEO, but strangely, this is not the case," Ms. Cook told SocialFunds.com

The
report finds that 84 percent of companies in the largest market capitalization category (greater
than $10.2 billion) had combined CEO and Board Chair positions. Meanwhile, 62 percent of the
boards of companies in the smallest market capitalization category (up to $183 million) have joint
CEO-Chairs.

"Boards with higher independence [according to NYSE-NASDAQ definition] also
have more outside CEOs serving on them as non-executive directors," said Ms. Cook. "Not only that,
boards that are headed by CEO-Chairs also tend to have more outside CEOs on the compensation
committee."

"I can't see these outside CEOs having any incentive to pioneer challenging
performance-related pay packages, because it would come back to bite them on their own boards," she
continued.

The report cites the example of Augustus Busch, chair and CEO (until June 2002)
of Anheuser-Busch (ticker: BUD), Edward Whitacre, chair and CEO
of SBC Communications (SBC), and Charles Knight, chair and
CEO (until 2000) of Emerson Electric (EMR). All three are considered
independent outsiders on each other's boards.

"While these designations are technically
correct, it is hard to imagine that one can be entirely unbiased by a co-membership relationship
[among these three CEOs] spanning at least 17 years, with a combined 27 full board meetings in the
last year, not counting committee meetings," wrote Ms. Cook in the report.

Ms. Cook sees
the potential for demand for TCL's Interlocks Tool from the social investment sector, as shareowner
activists could use it to identify directors and boards with both best- and worst-practice.

"On the one hand, they can leverage these methodologies to individualize responsibility for
board decision-making and identify decisions, or non-decisions, that have led to environmental
destruction or violation of human rights," Ms. Cook said.

"On the other hand, shareowner
activists could identify and support directors who are catalysts for change," she continued.
"Board practices spread through this director network, so it's definitely good to have these
individuals plugged into it, especially considering the studies showing that directors who are
proactive in initiating change tend to get sidelined in both the informal and formal networks."

The report ends by weighing in on the director election process, as the Securities and
Exchange Commission (SEC) is currently considering proposed changes.

"It would be an
excellent move to open up the nomination process to shareholders, but we would have to watch out
for new patterns of relationships that emerge after that," Ms. Cook concluded.